Risk Assessment and the LIHTC Program at Year 25 September 15, 2011

1. SEPTEMBER 2011 Tax Credit Investment Services Risk Assessment and the LIHTC Program at Year 25 September 15, 2011

2. The Importance of Risk Assessment • At any point in the past twenty-five years a bank executive could have made the following statement “The regulatory environment for banks is incredibly complex, bordering on the byzantine” • However contrast any one of those years with where we are in 2011: • Dodd-Frank Wall Street Reform and Consumer Protection Act • Seventy-two sets of Dodd-Frank regulations • International Financial Reporting Standards (IFRS) • Implementation of the Basel III Accords (1/1/13) • All of this has to do with getting Tier One (core) capital to be “adequate” • Why should the affordable housing industry care about risk-weighting and capital adequacy? • Roughly 85% of the housing credit equity market is attributable to banking institutions, to national banks in particular and most particularly, banks that are “systemically important” or have global systemic importance

3. The Importance of Risk Assessment • Reznick Group decided that the question of assessing the risk in LITC investments was too important to say “not my job” • The decision to update LITC property performance data ultimately had several purposes • Our original intent was to be responsive to concerns expressed by OCC officials, investors and others that the recession was likely to have pushed up the foreclosure rate and put the already “fragile” housing credit portfolio at further risk • The major banks are now at the point where they need to independently risk-rate all assets in preparation for Basel III implementation • The performance data when extrapolated from property to fund performance could prove useful if we are able to engage the FASB concerning the appropriate accounting for LITC investments

4. The Performance Study • The last major study of property performance covered property performance through calendar 2006. • We reached out to every active syndicator and virtually every firm participated. The study also includes non-overlapping data provided by Bank of America, Citibank, JP Morgan Chase, US Bancorp and others • Forty participants provided us with data covering a total of 16,300 properties • The study was based on properties that were in service at 12/31/10 and thus the first generation of LITC properties is not included • The study’s focus was on the operating performance of 14,700 properties that had achieved stabilization as of 12/31/09 and on their operating performance for the years 2008, 2009 and 2010 • The average property in the data-set had 77 apartments up from 64 units when the first comparable study was done in 2002

5. Portfolio Composition

6. Major Statistical Findings

7. Median Occupancy • Occupancy levels in LITC properties have been remarkably consistent from one year to the next without regard to the survey size and without regard, apparently, to economic distress • During 2008-2010, despite a national recession and large employment losses in most markets, LITC occupancy actually increased • Occupancy data for 2004-2006 vs. 2008-2010 (2007 has not been studied) • 2004 96.0% 2008 96.4% • 2005 96.0% 2009 96.3 % • 2006 96.1% 2010 96.6%

8. Median DCR

9. Debt Coverage • The most widely-used metric for operating performance is the debt coverage ratio (DCR) defined as the relationship between net income in a given year (including required replacement reserve deposits) and the debt service for that period • For LITC properties, “soft” debt is eliminated from the calculation • For most of the past decade, average LITC coverage has stayed in the 1.13 - 1.15 range. In theory, average DCR’s should increase over time as rents & expenses grow, in theory, at different rates • The properties we surveyed report DCR levels for the last three years of: 1.15 in 2008, stepping up to 1.19 in 2009 and to 1.24 in 2010

10. Median Debt Coverage • For the properties we surveyed, notwithstanding largely constant occupancy levels, average debt coverage increased by 3.5%, to 1.19 in 2009 and by an additional 4.2% to 1.24 in 2010 • For comparative purposes: E&Y StudiesReznick Study 2004 1.15 2005 1.15 2006 1.14 2008 1.15 2009 1.19 2010 1.24

11. Median Debt Coverage • Where did the growth in coverage ratios come from? • Our first reaction was these numbers cannot be correct – but they have been scrubbed and re-scrubbed • The precise answer to the question of why operations have improved is….we aren’t sure….but we’re working on it • Some possible explanations: • While physical occupancy has been flat, economic occupancy may have risen due to lower turnover • As older LITC deals cycle out, properties financed with higher credit prices make the typical LITC property “equity heavy/debt lite”. When hard debt is lower, even incremental changes in operating expenses have an out-sized impact • There is some evidence that operating expenses began to stabilize & rents increased during the 2008-2010 period

12. Median Per Unit Cash Flow

13. Cash Flow per Apartment Unit • Cash flow per unit is the average amount of net cash flow after debt service has been generated per apartment unit per annum • As with the other metrics, cash flow per unit increased at just 1% per annum between 2004 ($234 per unit) to 2008 ($246 per unit) • Between 2008 and 2010 (the recession years), cash flow per unit grew from $246 per unit to $335 in 2009 and $412 per unit in 2010 • Since movement in cash flows is tied to movement in debt coverage, it follows that cash flow improved in 2009 and 2010 • While the growth in cash flow from $246 to $412 seems dramatic at first blush, remember that this is an annual figure which translates to roughly $13,000 at the property level • Higher DCR’s and cash flow were largely consistent across all property types, tenancy types, geographically, etc

14. Median DCR by Placed in Service Year

15. Median Per Unit Cash Flow by Placed in Service Year

16. Operating Performance by Investment Type

17. Operating Performance: 4% vs 9% Projects

18. Operating Performance by Development Type

19. Operating Performance by Tenancy Type

20. Incidence of Underperforming Properties

21. Underperforming Properties • When the first E&Y study was published the industry was pleased with the outcome and with the foreclosure rate (.01%) in particular. This data: • Helped corporate managers better understand the risk profile • Helped convinced potential guarantors to enter the business • Convinced NAIC to change its risk-based capital charge from 20% to 2.6% • However, few readers seemed to focus on the fact that 1/3 of all LITC properties were operating below break-even and just under 20% reporting physical occupancy below 90% • At AHIC’s request, subsequent studies focused much more attention on the “LITC conundrum” – a tiny foreclosure rate while so many properties were operating below break-even

22. Historical Trend in Underperformance

23. Chronic Underperformance

24. Incidence of properties w/Severe Vacancy Issues

25. Incidence of Properties w/large negative coverage

26. The Cumulative Foreclosure Rate • Survey participants reported that the cumulative number of foreclosures between 1993 and 2010 was 98 and roughly 1/3 of these between 2008-2010 • The reported foreclosures do not include properties financed by eight syndicators that are now inactive. You can’t calculate the drop-out rate with precision if you only survey the graduates • While the foreclosure rate has increased, earlier estimates were distorted by syndication firms “feeding” troubled properties • While the cumulative foreclosure rate thru 2010 was 0.62%, this metric does not reflect the fact that the impact to investors was often very small • The foreclosure rate still compares favorably with any other real estate asset class

27. Has the inventory become more fragile? • The bottom line is that in virtually every category, LITC performance improved rather than worsened during the recession • Debt coverage ratios and cash flow improved incrementally in 2009 and 2010 as the tax credit inventory of tax credit deals has come to be more heavily represented by “equity heavy” properties • The incidence of underperforming properties in general and the number of chronically under-performing properties in particular has decreased by a significant level in recent years • The foreclosure rate needs more analysis and we need to develop a way to get to accuracy in this metric • We are also developing a severity of loss analysis to put the foreclosure rate in context

28. The Performance Study – Phase Two • We are currently at work on the second phase of the study, to be published by year end, which will consider: • The causes for improved operating performance over the past three years • What the net impact of the average foreclosure is to a corporate investor • What the average development cost is to build or rehab an LITC apartment unit, as well as • An analysis of what the impact has been of the location of CRA assessment areas on the pricing and availability of tax credit projects located outside those areas